How to Compare Mortgage Loans

One of the smartest things you can do when you take out a mortgage is compare quotes from several competing lenders. Researchers at Stanford University found that borrowers taking out a $200,000 mortgage saved over $2,300 when they obtained mortgage quotes from three or four lenders instead of one or two.

However, if you don't compare your offers correctly, the exercise is pretty meaningless and may not save you anything. Here's how to make the few minutes spent getting mortgage quotes work for you.

Pick Your Product

When shopping for a new home loan, knowing how long you plan to keep the property helps you and your loan officer choose the right product and pricing structure. It's silly to go around comparing hundreds loans that might not even be appropriate for you -- pick a program first. Here’s an example of how this works:

If you're buying or refinancing a house, intending to sell it and move in five years, you can choose from several products:

30-year fixed mortgage

15-year fixed home loan

Adjustable rate mortgage (ARM)

Hybrid ARMs, fixed for 3, 5, 7 or 10 years

The 30-year product is extremely stable; your interest rate will not change over the life of the loan. However, 30-year mortgages carry the highest rates.

The 15-year loan, like the 30-year fixed mortgage, has an unchanging rate, and that rate is usually about .5 percent lower than comparable 30-year mortgage rates. Because you pay your home off in half the time, your payments are larger and you pay much less interest over the loan’s lifetime.

An ARM may have a very low initial rate. That rate can change at regular intervals, up or down, but can only increase to a maximum of (usually) five or six percent over your initial rate. Your ARM might not hit its maximum rate, but it could.

The 3/1, 5/1, 7/1 and 10/1 loans are known as hybrids. They offer rates that are fixed for three, five, seven or ten years. The initial rates can be much lower than the 30-year or 15-year mortgage rates, and this could save you a lot of money. For example, if you plan to keep a home for five years, you could choose from a 30-year loan at 4.25 percent, a 15-year loan at 3.35 percent, and a 5/1 loan at 2.95 percent.

Shop Fast, Think Slow

Once you have a program, it's time to chose a lender. Don't waste time -- Mortgage rates change continually, like prices for stocks, bonds and other financial assets. So a rate quote from Lender A that you get on Monday can’t reliably be compared to one from Lender B on Thursday. Round up your quotes quickly so that you’re making valid comparisons, then take your time reviewing offers. A tool like LendingTree’s Mortgage Negotiator can help you crunch the numbers.

Understand the Limits of APR Disclosures

When you apply for a mortgage, your lender must give you a Good Faith Estimate, which indicates the costs of getting the mortgage, and a Truth-in-Lending disclosure, which tells you the cost of financing, including the interest rate and charges. These amounts are stated in the form of an Annual Percentage Rate, or APR.

Some shoppers think that all they have to do is choose the loan with the lowest APR, but it doesn't quite work that way. The limitations of APR include:

1. You can only compare two loans of the same type -- for example a 15-year fixed to another 15-year fixed, or a 5/1 ARM to another 5/1 ARM.

2. The numbers are accurate only if you keep the loan for its entire term. For example, if you pay $3,000 in upfront costs for your mortgage, that's $100 a year in fees if you keep the loan for its entire 30-year term. However, if you sell the home in just five years, your fees jump to $600 per year. This graphic shows how APR increases the less time your keep your mortgage.

In general, loans with higher upfront costs have lower rates, but it takes time for the savings created by the lower rate offset those costs. Loans with fewer upfront costs, even with higher rates, may be better for people who plan to sell, refinance or prepay the loan in just a few years.

3. APR isn't calculated the same way by all lenders. Some include mortgage insurance on their FHA loans, for example, while others do not. APR was really designed more for consumer accounts like credit cards, not mortgages. It's helpful, but shouldn't be the only basis for choosing a loan.

Finally, no loan quote or offer is cast in concrete until you lock it in. It can be helpful to check with a couple of competing lenders before locking in your loan with your chosen company.